The Benefits and Burdens of Kodak from a Litigant's Perspective

As co-counsel for plaintiffs in the Kodak case, we were obviously pleased by the result, which went beyond the Ninth Circuit version of the case which was affirmed. Nonetheless, we have advised both manufacturer and aftermarket clients in other Kodak contexts that the case presents both benefits and burdens to post-Kodak antitrust litigants. The benefits to plaintiffs (and burdens to defendants) include a strong recognition of aftermarkets, a reaffirmation of Aspen Skiing Co v. Aspen Highlands Skiing Corp., 472 U.S. 585 (1985), a limitation of legitimate business justifications, and a lessened likelihood of summary judgments. The benefits to defendants (and burdens to plaintiffs) include the allowance of business justifications as a complete defense, the preservation of Continental T.V., Inc. v. GTE Sylvania, Inc., 433 U.S. 36, 55 (1977), in a horizontal context, and the preservation of the doctrine enunciated in United States v. Colgate & Co., 250 U.S. 300, 333 (1919).

PUTTING KODAK IN PERSPECTIVE The Kodak case would have been much more significant had the dissenters prevailed. Their explicit goal was judicial economy through the rejection, in principal, of even the idea that consumer welfare can be harmed if manufacturers of complex durable equipment are allowed to recover monopoly profits in servicing or adding on derivative "peripherals" to their products.

Historically, new industries and new markets have grown out of goods and services that basic equipment manufacturers initiated and whose derivatives they sought to control. Consider two examples: computers and cars.

Manufacturers of computer hardware have wanted to reap the profits from selling the software which expands the utility of their computers. But independent programmers (many of whom were trained by the basic manufacturers), who do not build computers, have provided an explosion in value-added productivity which dwarfs basic equipment earnings. These independents have produced this result by competing in the aftermarkets for software.

Similarly, repair services owned or licensed by the major automobile manufacturers have proven relatively unsuccessful with the car-owning public in competing with independent mechanics and corner garages. Four drivers out of five prefer the quality and price of independent auto repair services. An amicus brief filed in Kodak by several auto crash parts insurers indicates that many of them do too. The servicing of cars now adds more to the gross national product than their manufacture.

As the majority in Kodak stated, the dissent proposed perse immunity to manufacturers seeking to compete in new aftermarkets which develop out of their basic equipment. The consequence of such a rule would have been to exempt "a vast and growing sector of the economy from antitrust laws".[1]

At the present time services contribute more to U.S. national income than basic manufacturing.[2] That trend is likely to continue. By merely saying that manufacturers are not automatically free from antitrust liability if they seek to leverage their manufacturing capability to require highly differentiated and specialized parts and maintenance, into dominating these emerging aftermarkets, the Kodak majority has followed traditional precedents and conventional microeconomic analysis, and almost certainly fostered product and service innovation. Would we have a Microsoft today if IBM had been free to dominate software innovations?

BENEFITS TO PLAINTIFFS FROM KODAK

Recognition of Aftermarkets

The Court stated in no uncertain terms that antitrust violations could occur in aftermarkets as well as in any other market: "... when the Court has considered tying in derivative aftermarkets by manufacturers, it has not adopted any exception to the usual antitrust analysis, treating derivative aftermarkets as it has every other separate market." Kodak, 112 S. Ct at 2089 n.29. More importantly, the Court recognized that horizontal competition can occur in these aftermarkets:

Unlike Continental T.V., this case does not concern vertical relationships between parties on different levels of the same distribution chain. In the relevant market, service, Kodak and the ISOs are direct competitors; their relationship is horizontal.

Id. at 2084 n.14.

This recognition of aftermarkets may cause developments in a line of cases involving IBM product innovations in the 1970s. In Telex Corp. v. IBM, 367 F. Supp. 258, 304 (N.D. Okl. 1973), rev'd on other grounds, 510 F.2d 894, cert. dismissed, 423 U.S. 802 (1974), the court found that IBM's product changes "represented a legitimate technological and performance advance consistent with trends in the industry and at significant decreased cost."

Peripheral devices used with a computer's central processing unit were the subject of the Telex case. In the early 1970s IBM began manufacturing certain peripheral devices, such as disk drives and printers, which were compatible with IBM machines. Telex, 510 F.2d at 899. Soon after, competitors began making similar devices, which were also compatible with IBM machines. In response to this competition, IBM developed new peripheral products, and installed an adapter into the CPU itself, without which it was impossible to operate the peripherals. Id. at 901. IBM's competitors brought suit, alleging that the installation of this adapter prevented them from being able to compete with IBM.

Both the District Court and the Court of Appeals disagreed. The Court of Appeals held that "technical attainments were not intended to be inhibited or penalized by a construction of section 2 of the Sherman Act to prohibit the adoption of legal and ordinary marketing methods already used by others in the market...." Id. at 927. The Court also found that IBM's reduction in price of its peripheral devices was not predatory because IBM was still making a reasonable profit on the sale of its products. Id. In other words, there were legitimate reasons for IBM's actions.

Likewise, in California Computer Products v. IBM, 613 F.2d 727 (9th Cir. 1979), the Ninth Circuit found that IBM had a legitimate business reason for implementing certain design changes that had an adverse impact on its competitors. CalComp also involved IBM peripheral devices. The plaintiff competed with IBM by buying IBM peripheral equipment, reverse engineering the product by taking it apart, and building a similar peripheral device. As in the Telex case, IBM changed the design of its peripheral products and lowered its costs in response to this competition. The plaintiff claimed that the design changes were "'technological manipulation' which did not improve performance." Id. at 744.

The Court, however, found that "[t]he evidence at trial was uncontroverted that integration was a cost-saving step, consistent with industry trends, which enabled IBM effectively to reduce prices for equivalent function." Id. The court also pointed to evidence presented at trial that showed the design changes did improve performance of the machines. Id.[3]

The issue of a manufacturer foreclosing an aftermarket competitor by these or similar means will likely become more prevalent with continuing and accelerating developments in high technology. For example, a computer manufacturer may develop a diagnostic for use in servicing its computers and allow access to that diagnostic to its competitors. Diagnostics are software used to diagnose a problem with a computer quickly and effectively so that the problem may be fixed rapidly. The manufacturer, however, may prevent its competitors from gaining access to a non-proprietary computer chip necessary to operate the diagnostic. If the manufacturer is locking out access to the chip for anti competitive reasons, such an action may well constitute an antitrust violation--even though it may be unilateral.

Another example concerns Microsoft, which is reportedly under investigation by the FTC for its alleged unfair trade practices with regard to certain undocumented features (features not explained in the software manual) contained in its software.[4] According to some Microsoft competitors, these undocumented features are making it more difficult to compete with Microsoft because the competitors do not have access to certain coding mechanisms and must make up their own. Because of their lack of knowledge of Microsoft's undocumented features, Microsoft's competitors are claiming that they are not on a level competitive field with Microsoft. On the other hand, Microsoft's motivation may be benign. Whether Microsoft will demonstrate that to the FTC and other potential litigants remains to be seen.

Reaffirmation of Aspen Skiing Another Kodak benefit for plaintiffs is that one of the Supreme Court's most controversial recent antitrust cases has been given new vitality. Aspen Skiing Co v. Aspen Highlands Skiing Corp., 472 U.S. 585 (1985), was cited with approval in Kodak.[5]

The manner in which the ISOs in the Kodak case at first flourished because of Kodak's cooperation and then were devastated because of Kodak's withdrawal of that cooperation is similar to Aspen Skiing. In Aspen Skiing the owner of profitable ski resorts at three out of four mountains in an area decided to cooperate with a ski resort at the fourth mountain in the area in order to increase profits. When the venture no longer suited the monopolist's purposes, he cut off his competitor with no legitimate business justification. Id. at 594. The Supreme Court unanimously held that this conduct violated the antitrust laws. Id. at 611.

Aspen Skiing stands for the proposition that a monopolist violates Section 2 when it discontinues long-standing distribution policies which, by virtue of having been longstanding, were presumed to be efficient, in "a deliberate effort to discourage its customers from doing business with its smaller rival." Id. at 610. Such a change alters the character of the market, or the "patterns of distribution" that have developed over time: "By disturbing optimal distribution patterns, one rival can impose costs upon another, that is force the other to accept higher costs." Id. at 604, n.31 (quoting R. Bork, The Antitrust Paradox 156 (1978) ).

The implications are particularly important regarding aftermarkets: competitors in aftermarkets are often dependent on the manufacturer in one way or another, almost by definition. It is likely that we will be seeing more cases involving aftermarkets in which plaintiffs are relying on Aspen Skiing. Justice Scalia in his dissent in Kodak viewed this prospect with barely restrained concern: "the Court's opinion threatens to release a torrent of litigation and a flood of commercial intimidation that will do much more harm than good to enforcement of the antitrust laws and to genuine competition." Kodak, 112 S. Ct. at 2094 (Scalia, J., dissenting).

Of course, the opposite may be even more true. Manufacturers faced with Kodak and the inevitability of jury trials for antitrust challenges of blatant attempts to monopolize aftermarkets may well minimize those risks by accepting the necessity of competition from independents in servicing their manufactured goods. After all, car manufacturers have come to accept, reluctantly, that independent garages servicing their vehicles are a fact of competitive life.

Business Justifications The good news for defendants in Kodak is that a business justification is still a complete defense.[6] The IBM cases cited above are still good law in that regard.

The good news for plaintiffs is that certain oft-used business justifications have now been limited or eliminated. Free-riding, for example, has been limited. Kodak argued that Continental T.V. and Monsanto v. Spray-Rite Service Corp., 465 U.S. 752 (1984) supported its business justification that it was merely attempting to eliminate free riders. Kodak, 112 S. Ct. at 2092 n. 33. The Court rejected Kodak's free-rider defense, holding that "[t]his understanding of free-riding has no support in our case law." Id. at 2092.

As the Court explained, both Continental and Monsanto concerned vertical relationships; the retail sale of televisions and the retail sale of herbicides, respectively. Id. The Court distinguished those cases:

Some retailers were investing in those markets; others were not, relying instead, on the investment of the other retailers. To be applicable to this case, the ISOs would have to be relying on Kodak's investment in the service market; that, however, is not Kodak's argument.

Id. The Court held that Kodak's argument would only have been successful if the ISOs were free-riding off Kodak's investment int he service market, which they clearly were not.

Other business justifications have been curtailed. In addition to its free-rider argument, Kodak proffered two other business justifications. Kodak first claimed a business justification similar to that argued by Mercedes in the Mozart case. Kodak argued that its policy was necessary to insure that customers received quality service so that Kodak could compete effectively in the interbrand market. Kodak's justification was that it feared that owners of Kodak equipment would blame Kodak for problems those customers experienced with ISOs. In rejecting this argument, the Court found that the ISOs presented evidence that they provided higher quality service than Kodak in some instances. Second, Kodak claimed that its policy was necessary to control and reduce inventory costs; the Court found this justification to be pretextual because inventory costs have little or no relationship to which company repairs the machine.

Limitations on Summary Judgment A major benefit to plaintiffs from Kodak is increased difficulty for defendants to win a summary judgment motion. Kodak argued that another antitrust summary judgment case, Matsushita Electric Industrial Co. v. Zenith Radio Corp., 475 U.S. 574, 587 (1986), dictated the result in the Kodak case. According to Kodak, Matsushita held that when a plaintiff's theory in an antitrust case does not make economic sense, a defendant is entitled to summary judgment. Thus, Kodak argued, the burden on a plaintiff in seeking to avoid summary judgment in an antitrust case is greater than in other cases.

The Supreme Court, however, did not agree. It held that the burden on plaintiffs in antitrust cases is no more stringent than in other cases:

The Court's requirement in Matsushita that the plaintiffs' claims make economic sense did not introduce a special burden on plaintiffs facing summary judgment in antitrust cases....Matsushita demands only that the nonmoving party's inferences be reasonable in order to reach a jury, a requirement that was not invented, but merely articulated, in that decision.

The Court also held that a defendant moving for summary judgment in an antitrust case on the ground that the plaintiff's theory does not make economic sense "bears a substantial burden in showing that it is entitled to summary judgment." The Court specifically held that "...[i]n this situation, Matsushita does not create any presumption in favor of summary judgment for the defendant."

BENEFITS TO DEFENDANTS

Preservation of Sylvania One of the major benefits to defendants from Kodak is that Kodak has very little to say about vertical restraints. In no way does it limit Continental T.V., Inc. v. GTE Sylvania, Inc., 433 U.S. 36, 55 (1977) in a vertical context. It is true that to the extent ISOs in the Kodak case were dependent upon Kodak as a source of repair parts for Kodak equipment, they were vertical customers of Kodak. However, unlike Continental T.V. vis-a-vis Sylvania, they were not asserting a right to be Kodak distributors competing with distributors of the products of Kodak's competitors. They were seeking to compete with Kodak itself in providing maintenance services to Kodak customers. This is interbrand, i.e., horizontal, not intrabrand competition.[7]

Some commentators have suggested that the Kodak case jeopardizes the ability of manufacturers to offer a package of basic equipment with aftermarket services without thereby running the risk of facing a tying challenge. This analysis may go too far. A firm which offers a bundling of support and maintenance services with the sale of basic equipment as one of a variety of marketing options probably does not run afoul of the antitrust laws.[8]

Others have suggested that the Kodak case opens a wide door for rampaging plaintiffs lawyers because it makes a monopoly or tie-in case against any branded basic equipment product, even one with a one percent market share, where those who repair that product are dependent upon the branded manufacturer for repair parts. It may be true that a firm can exact some leverage whenever other's equipment is not a ready substitute for its own.[9] However, there is nothing in the Kodak opinion which says the Supreme Court will find a relevant service market for the servicing of a branded product which itself has only a tiny market share. The Court leaves open to a case-by-case determination whether competitive injury can result if a marginal manufacturer seeks to control a relatively small aftermarket as a means of survival in the basic equipment market. There are sufficient existing barriers to the successful prosecution of plaintiffs antitrust cases such that the risk of strike suits against marginal players is deminimis.

The Preservation of Colgate There is a tension between encouraging innovation and discouraging anti-competitive behavior. Ever since United States v. Colgate & Co., 250 U.S. 300, 333 (1919) a private business is generally free to deal with whomever it chooses; however, that conduct must be "[i]n the absence of any purpose to create or maintain a monopoly...." Thus, if in foreclosing a competitor a firm has the specific intent to create or further its monopoly, such conduct would violate the antitrust laws. The key to whether foreclosing a competitor from access to tools necessary to compete is an antitrust violation lies in whether the manufacturer has a legitimate business justification for such behavior.

The effort to make Kodak seem a radical departure from traditional antitrust is nowhere better manifested than in the suggestion by some that Kodak overturns Colgate. In fact, that is not the case, which benefits defendants.

In footnote 32, the Kodak majority makes the following statement (citing Aspen) :

It is true that as a general matter a firm can refuse to deal with its competitors. But such a right is not absolute; it exists only if there are legitimate reasons for the refusal.

As the preceding discussion (and the text of the rest of the opinion in Kodak) indicates, the Court is only referring to unilateral refusals to deal by firms with market power. A firm lacking market power can unilaterally refuse to deal with impunity.

Because it was reviewing a motion for summary judgment, the Court had to accept the following facts as to which plaintiffs offered some credible evidence:

1) Before the mid-1980s, Kodak sold replacement parts for which no substitutes existed, for its micrographic and copying machines to anybody willing to purchase them. 2) These included several former Kodak employees who set up independent repair shops to service Kodak machines. 3) After some ISOs became successful, Kodak implemented a policy of selling such Kodak parts only to buyers of Kodak equipment who used Kodak service, or repaired their own machine, and only to those who agreed to refuse to resell such parts to independent service organizations. 4) Kodak then got original equipment manufacturers of those parts Kodak did not fabricate to agree not to sell such parts to anyone other than Kodak. 5) Kodak did not tell purchasers of their basic equipment at the time of purchase that they had to deal only with Kodak in maintaining their equipment and did not tell them what the cost of such maintenance would be. 6) Kodak restricted the availability of used machines to prevent their becoming an independent source of Kodak replacement parts.[10]

If servicing Kodak basic equipment is a distinct market, like servicing cars is distinct from manufacturing them; and if Kodak sought to and succeeded in eliminating competition from others in this market, there is nothing radical in saying that Kodak's alleged conduct could be an antitrust violation. Of course plaintiffs now have to go back and prove these facts by a preponderance of the evidence at trial. What is so surprising is not the result in this case but that so many commentators should find it surprising and disturbing.[11]

One interesting question which the Kodak case leaves unanswered is whether Kodak would have run afoul of the rule in Colgate if it had engaged from the outset in a policy of refusing to sell Kodak parts to independent servicers. If that is all Kodak had done, its conduct might have survived challenge. ISOs would still have been free to negotiate with OEMs as an alternative source of parts, would have been free to buy used Kodak equipment as a source of parts, and would have been free to buy Kodak parts resold by those direct purchasers with whom Kodak was willing to deal. If that is all Kodak had done, a legal challenge might well have clarified the limits of the Colgate doctrine. Concededly, those limits remain hazy. But plaintiffs suits are rarely brought to settle fine points of the law. It was Kodak's alleged concerted and comprehensive policy to foreclose all sources of parts that makes this an easy case to reject summary judgment. The defendants likely to face future plaintiffs' challenges are those whose conduct shows a blunt hostility to horizontal competition.

CONCLUSIONKodak was not so much a departure as it was a return to basics. Had Kodak won, there would have been a major departure, because aftermarkets -- in which most economic activity occurs today -- would have been exempt from the antitrust laws.

Victory by plaintiffs, on the other hand, is far less clear-cut in the long term. Defendants have lost a battle, but the war will rage on. That future battles will be decided more by facts than by theories will come as no surprise to those familiar with the history of the Sherman Act.

Ron Katz is Managing Partner in the San Francisco Office of the international law firm Coudert Brothers. He has developed a substantial practice advising both plaintiffs and defendants regarding antitrust issues in aftermarkets. He filed two amicus briefs in Kodak.

Doug Rosenthal is a Partner in the Washington Office of Coudert Brothers. Formerly Chief of the Foreign Commerce Section of the Antitrust Division, he was the principal draftsman of the plaintiffs' Supreme Court brief in Kodak.

The authors gratefully acknowledge the assistance of their colleague, Janet S. Arnold, in the preparation of this article.

6. Even if a plaintiff establishes the existence of a perse tying violation, a defendant will prevail if it had a legitimate business justification for its conduct. See, e.g., Mozart v. Mercedes Benz of North America, Inc., 833 F.2d 1342 (9th Cir. 1987), cert. denied, 488 U.S. 870 (1988). In the Mozart case, the court found that Mercedes had a legitimate reason for requiring its franchise dealers to use only approved Mercedes parts. According to the Ninth Circuit, Mercedes demonstrated that the tying arrangement was necessary in order to protect its reputation.

That particular business justification does not always allow manufacturers to escape liability, however. On similar facts the Fourth Circuit found that the defendant had no legitimate business justification for its conduct. Metrix Warehouse v. Daimler-Benz Aktiengesellschaft, 828 F.2d 1033 (4th Cir. 1987), cert. denied, 486 U.S. 1017 (1988).

"Despite [Kodak's] best effort, repeating the mantra interbrand competition cannot transform this case into one over an agreement the manufacturer has with its dealers that would fall under the rubric of Continental T.V."